350_Ch09A[1]

350_Ch09A[1] - Appendix 9A Stock Market Equilibrium...

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Appendix 9A: Stock Market Equilibrium Answers and Solutions 1 Appendix 9A Stock Market Equilibrium Solutions to End-of-Chapter Problems 9A-1 a. r i = r RF + (r M – r RF )b i . r C = 7% + (11% – 7%)0.4 = 8.6%. r D = 7% + (11% – 7%)(-0.5) = 5%. Note that r D is below the risk-free rate. But since this stock is like an insurance policy because it “pays off” when something bad happens (the market falls), the low return is not unreasonable. b. In this situation, the expected rate of return is as follows: C rˆ = D 1 /P 0 + g = $1.50/$25 + 4% = 10%. However, the required rate of return is 8.6%. Investors will seek to buy the stock, raising its price to the following: . 61 . 32 $ 04 . 0 086 . 0 50 . 1 $ P ˆ C = = At this point, % 6 . 8 % 4 61 . 32 $ 50 . 1 $ C = + = , and the stock will be in equilibrium. 9A-2 a. r s = r RF + (r M – r RF )b = 6% + (10% – 6%)1.5 = 12.0%. 0 P ˆ = D 1 /(r s – g) = $2.25/(0.12 – 0.05) = $32.14. b.
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This note was uploaded on 09/30/2011 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.

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350_Ch09A[1] - Appendix 9A Stock Market Equilibrium...

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